With global private equity fundraising at record highs, key jurisdictions across the world have been busy revising their tax and regulatory regimes to compete and attract capital.
From Europe to Asia and the US, managers have more choices than ever. But in such a competitive environment, what sets some jurisdictions apart from others? Flexibility and a deep talent pool are one of the keys, says one tax lawyer, who singles out Luxembourg as a jurisdiction that has raised its game in recent years and is now often the first port of call for managers and investors.
Under the Alternative Investment Fund Managers Directive, European alternative fund managers can apply for a passport to distribute alternatives funds within the EU. Funds were previously sold on a private placement basis with different rules for different countries, known as national private placement regimes, which allows alternative investment fund managers to market their funds to Europe without going through a passport regime.
“In the past, service levels in Luxembourg were much lower and the cost of professionals was much higher than in the Channel Islands. That’s been changing and since Luxembourg enacted new laws bringing in English-style limited partnerships, which are much more flexible than historic Luxembourg vehicles, and with the impetus given by Brexit and expectations of how AIFMD will be applied post-Brexit, Luxembourg while still expensive has become more attractive,” says John Daghlian, partner at law firm O’Melveny.
He says because a fund can set up an English-style limited partnership in any of the Cayman Islands, Luxembourg or the Channel Islands “they are almost interchangeable. But as a general rule post-Brexit and with the growth of AIFMDs for hire, Luxembourg is the place we think of first.”
The UK’s planned secession from the EU and regulation in the way of tax strategies around the base erosion and profit shifting are pushing funds to Luxembourg.
“We’re seeing more ‘onshorification’ [in Luxembourg] because of a number of trends including Brexit and the BEPS initiative,” says Laurent Thailly, a partner at Ogier. “If anything that has led to growth here because it makes a more compelling case for basing full structures (SPVs and funds) in the jurisdiction, and for managers to establish presences or to increase their footprints here in Luxembourg.”
“With all of that comes pressure on talent – market pressure created by the consistent growth over the last few years has put a premium on talent. This is a good problem to have – there’s a competitive market for talented people, and firms have to demonstrate ambition, innovation and focus to attract the best people, and thus to succeed.”
An alternative jurisdiction that some private equity executives have been touting is Ireland.
“Ireland is a bit less accessible than other jurisdictions, but one thing you do get there is access to a larger educated population compared with the smaller populations on the Channel Islands and Luxembourg,” Daghlian says. “It has not historically been used for private equity but has been successful with UCITS.” Undertakings for Collective Investments in Transferable Securities are mutual funds that are regulated by the EU.
Still, others say Jersey stands to benefit from Brexit.
“Looking ahead, lack of clarity over Brexit is leading UK managers to reconsider the location of their funds and of their managers,” according to Emily Haithwaite, a partner at Ogier. “We expect Jersey to benefit from the certainty it has in its relationship with the EU and the ability for it to access investors under the NPPR regime.”
Daghlian says that for European GPs and investors, jurisdictions like Luxembourg and the Channel Islands have pulled away from the Cayman Islands because “to European eyes the Caymans are perceived to be a little less attractive than the Channel Islands because the Channel Islands are highly regulated, and the Caymans are felt to be less so.”
A ‘real economy’
The Netherlands has remained a popular destination for private equity funds, but Daghlian says the country “is perhaps less friendly because the regulator is less interested in making things easy for private equity. It tends to be used for [special purpose vehicles] rather than fund structures and it’s not trying to compete with other jurisdictions.”
He says that compared with the Channel Islands and Luxembourg, the Netherlands is “a real economy” so it doesn’t have to fight as hard for private fund business.
Outside of Europe, Asia is booming and a mini-revolution of jurisdictional reform is taking place, with three key locations increasingly vying for global business.
“Previously local domiciliation for private funds was an elaborate process and less competitive in comparison to other available alternatives, but in recent years we have observed multiple initiatives, primarily in Hong Kong, Singapore and Australia that will create incentives to domicile in these jurisdictions,” says Srikumar TE, president of fund administrator Apex.
He says Hong Kong this year established a regulatory framework for a new open-ended company fund structure that works like a trust – facilitating capital changes and distribution of dividends that doesn’t require the traditional approval of shareholders.
“It provides a viable alternative to structures available in the Caymans and Luxembourg and it offers a greater degree of oversight, as it requires registration with the Securities and Futures Commission and must be managed by a SFC-licensed asset manager,” Srikumar says. “It also allows the creation of ring-fenced sub funds, segregating assets, and this makes Hong Kong a viable alternative for managers that would previously have gone to the Caymans or the British Virgin Islands.”
Still, Hong Kong remains “the gateway to China,” he says.
The other regional superpower on the Asian continent when it comes to fund domiciles is Singapore, and Srikumar says that a new corporate legal vehicle designed for collective investment schemes – Singapore Variable Capital Company (S-VACC) – is expected to be available by mid-2019.
“It permits setting up both as an open-ended and closed-ended fund structure, and is robust when compared to similar alternatives in Cayman, Ireland and other prominent fund centers. SVACC has its own legal framework and requires the fund manager to be in Singapore.”
And then there is Australia, which has developed the collective corporate investment vehicle. Available on a retail and wholesale basis, a key feature of the CCIV is the ability to secure an Asian passport under this new regime, creating a multilateral framework for funds to market cross-border to Asian investors, Srikumar says.
“The goal is to create a structure where fund managers can offer their products to foreign investors. In the traditional world of collective investment schemes the segregation of participating and non-participating shareholders rights simultaneously balancing their respective controlling powers was a key feature in structuring funds and this is hopefully achieved with these initiatives” in Hong Kong, Singapore and Australia.
Daghlian says that many Asian funds are also based in Mauritius if they are investing in Asia or Africa.
“Most Indian funds will have a Mauritian main fund or Mauritian feeder into an Indian trust. Administrators there are also affordable,” he says.
One element of the global fundraising boom has been the rise of first-time funds. So what are the options for these managers? Daghlian says Luxembourg remains an attractive option: “In Luxembourg there are a number of service providers licensed to be fund managers operating a turnkey AIFM compliant service. For a first-time fund especially the advantage is you can launch pretty quickly with a full scope AIFM vehicle and market using the passport.”
He says that with regulatory pressures growing, smaller and smaller funds are opting for Luxembourg despite the cost. “In the past you wouldn’t have wanted to go to Luxembourg with a fund of less than £300 million ($391 million; €337 million) because of the costs, but firms are going there now with smaller-fund sizes because they want to future-proof structures. This is a new development. The European Investment Fund is also very keen for people to go, and they are big backers of new managers in Europe.”
Srikumar says debut funds should bear in mind their future vehicles and not just respond to the desires of their inaugural round of investors. “Usually the domicile for a first-time fund will be heavily influenced by the preferences of the initial/seed investors. But GPs must look forward at their future potential investor base and identify a jurisdiction that will be appealing to the next round of investors as well. Among the various factors they must consider are regulatory and political robustness of a jurisdiction and the ability of a jurisdiction to market itself.”
This story has been amended to attribute comment in the 13th paragraph on jurisdictions in Luxembourg, the Channel Islands and the Cayman Islands to John Daghlian.